11 auditor’s legal liability

Auditor’s Legal Liability

Lawsuits typically faced by auditors

Alleged misstatements

– Improper or inadequate disclosure

– Inappropriate valuation

Non-discovery of fraud resulting from

negligence

Delayed completion of audit

Inappropriate withdrawal from an audit

Expectation Gap

Auditors guarantee the accuracy of

financial statements

Auditors guarantee the financial viability of

the business

PSA 250

Consideration of Law and Regulations in an

Audit of FS

Auditor should recognize that non-

compliance by the entity with laws and

regulations may affect the FS.

“Non compliance” are acts of omission or

commission by the entity being audited,

either intentional or unintentional which

are contrary to prevailing laws or

regulations.

PSA 250


Audit of FS - Auditor’s Responsibility

Auditor should recognize that non-

compliance by the entity with laws and

regulations may affect the FS.

“Non compliance” are acts of omission or

commission by the entity being audited,

either intentional or unintentional which

are contrary to prevailing laws or

regulations.

PSA 250


Audit of FS - Auditor’s Responsibility

Noncompliance is a legal determination

beyond the auditor’s professional

competence

Laws and regulations vary considerably in

their relation to the FS

Auditor’s responsibility for Fraud is

provided in PSA 240

Indications of Noncompliance

Government investigation

Payment for unspecified services

Excessive sales commissions and agent’s fees

Purchases significantly below or above market price

Unusual cash payments

Unusual transactions with companies in tax havens

Indications of Noncompliance

Payments other than to the country of

origin of goods

Payments with lacking documentation

Accounting systems without adequate

audit trail

Unauthorized or improperly recorded

transactions

Media comment

Management’s Responsibility

Monitoring legal requirements

Instituting & operating appropriate IC

systems

Code of Conduct (creation, employee

training, monitoring)

Engaging legal advisors

Maintaining a register of significant laws

Auditor’s procedures for obtaining a

general understanding of laws &

regulations affecting the client

Knowledge of industry & business

Inquiry & discussion with management

Considerations when auditor

detects noncompliance

Potential financial consequences

Whether the fncl consequences needs

disclosure

Whether the fncl consequences are so

serious to question the fair presentation of

the FS.

document findings and discuss with

management

Reporting of noncompliance

To management

To the users of the auditor’s report on the

financial statements

To regulatory and enforcement authorities

Withdrawal from the engagement

• When entity does not take remedial action

Legal Concepts Related to

Auditor’s Liability

Due Professional Care

– Prudent person concept

Sources of Responsibility

– Common law -> laws that have been

developed through court decisions rather than

government statutes

– Statutory law -> laws passed by legislative

bodies



Degree of Wrongdoing

Degree of wrongdoing

None Negligence

(Ordinary)

Gross

negligence or

Constructive

Fraud

Fraud

Auditors

perform

appropriate

audit and issue

appropriate

report

Auditors did not

do what a

reasonably

prudent auditor

would do

Auditors

consistently fail

to follow the

standards of

profession on

an engagement

Auditors issue

report on

financial

statements with

the intent to

deceive



Lack of privileged communication

– Under common law, information obtained by a

CPA from a client is not privileged. Court may

subpoena these information.

Liability for acts of others

– Partners are jointly liable for civil actions

– Partners are also liable for work of others like

employees, other CPA Firms and specialists

Legal Liability of the Independent

Auditor

Liability to clients

Liability to 3rd parties

Liability of the CPA under the NIRC

Section 321 C


Auditor


- obliged to exercise due professional care

during the engagement including adherence to

professional standards and ethics.

- failure to exercise this degree of care may

constitute negligence and breach of contracts to

render professional service.

-Honest errors does not constitute negligence so

long as he exercised due professional care.


Auditor


-undetected widespread fraud not detected by

auditors

- inadequate procedures were performed

- auditor is negligent

- client is entitled to recover any losses to which

the auditor’s negligence is the proximate cause

- client may also recover the audit fee for

auditor’s breach of contract.


Auditor

Liability to third parties– Auditors are liable to all foreseeable third

parties for losses which are caused by the

auditor’s fraud or gross negligence.


Auditor

Liability of the CPA under the NIRC– Ensure client pays the right kind and proper

amount of tax

– Second responsibility – interest of the govt.

(BIR)

– Not obliged to investigate info. Provided by

taxpayer but cant just disregard clues that

cast doubt on the accuracy of these data.


Auditor

Liability of the CPA under the NIRC Section 321 C

– Wilfully falsify report

– Certifies FS containing essential misstatement of facts

or omission of transaction –taxable income,deduction,

exemption of client

– Not being an independent CPA doing the examination

and audit of taxpayers’ books

Penalty:

- Fine of not exceeding P5000 and imprisonment of not

less than 2 years, plus cancellation of CPA license.

Limitation on Auditor’s

ResponsibilityIf circumstances indicate the possible

existence of fraud & errors, the auditor

should consider the potential effect on the

financial information.

If material, auditor should perform

appropriate modified and additional

procedure to confirm or dispel such

suspicion

(Based on PSA 240)

Limitation on Auditor’s

ResponsibilityThe auditor should communicate his

findings to management on a timely basis

if:

– He believes fraud may exist even if potential

effect is immaterial, or

– Fraud or significant error is actually found to

exist

(Based on PSA 240)

Auditor’s Defenses

Against client lawsuits

Against 3rd party lawsuits


Against client lawsuits

1) lack of duty to perform the service

2) performed with reasonable care or lack

of reasonable care did not cause damages

3) absence of causal connection

4) contributory negligence

5) statute of limitations has expired.


Against 3rd party lawsuits

1) Non-negligent performance

2) Privity of contract

3) Absence of causal connection

4) Statute of limitations has expired.

Minimizing exposure to legal liability

Emphasize compliance with ISAs, Code of

Prof. Ethics and IFRS.

Thoroughly investigate prospective clients

Avoid companies where risk of litigation is

so high

Exercise extreme care in the audit of

clients w/ financial difficulties

Establish and follow QC procedures

Minimizing exposure to legal liability

Use clear engagement letters –scope &

responsibilities

Conduct audit w/ prof. skepticism

Provide opportunity for auditors to consult

with more experienced auditors about

difficult issues

Maintain professional liability insurance

coverage

Seek legal counsel whenever serious

problems occur.

11 auditor’s legal liability

Documents